What's In The Wall Street Regulation Bill?

The Senate passed its big finance-reform bill late last night. Here are a three of the central issues the bill addresses.

Too Big To Fail

The bill gives the government the authority to take over and sell off failing financial firms. It also creates a panel that's supposed to monitor large financial firms whose failure could present broad risks to the financial system. The panel can limit how much money those firms borrow, and require the firms to hold more capital in reserve.

These measures were created because the normal bankruptcy process doesn't work very well for big financial firms; their ties to other businesses can make bankruptcy very disruptive for the financial system.

That has left the government with the unappealing options of letting firms go bankrupt and watching the financial system melt down (see: Lehman Brothers) or bailing out firms with taxpayer money (see: everybody else).

Supporters say the bill will allow firms to fail without bringing down the financial system, and without leaving taxpayers on the hook for bailouts.

But many economists say that very large financial institutions will always be deemed too big to fail in a crisis. An amendment that would have forced the nation's largest banks to shrink their balance sheets was voted down in the Senate.

Derivatives

The bill requires most derivatives to be traded on exchanges, and to go through a central clearinghouse.

Derivatives, also known as swaps, are contracts that allow businesses to hedge risk or to make speculative bets. They offer big profits, and create large risks; they were central to the failure of AIG.

Most derivatives are traded over the counter, in private: One banker calls another, and they make a deal. Nobody knows what the deal is. This allows financial institutions to take on large amounts of risk with derivatives, largely in private.

Requiring trades to go through a central clearinghouse means that if one party to a contract goes bankrupt, the clearinghouse will step in and make good on the deal. Requiring trades to be posted on an exchange means the flow of trades, and the prices, will be available to the public.

The bill also requires banks to spin off their lucrative derivatives units into separate businesses. This is meant to move the risk associated with derivatives away from banks. Opponents of this piece of the measure — which is not included in the House version of the bill — argue that it could push derivatives trading overseas, to less-regulated markets.

Consumer Protection

The bill creates a new Consumer Financial Protection Bureau. It's housed within the Fed, but has a director appointed by the president. The notion behind the bureau is that existing regulators' top priority is financial institutions themselves, not consumers.

Backers of the bill say a consumer-focused agency will, among other things, force lenders to give borrowers a clear picture of what they're getting into. This may reduce the risk that borrowers will take out loans the do not understand and cannot afford.

Opponents say the agency may create regulations that burden lenders and drive up costs for borrowers.

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